Bigger Isn’t Always Better: How A Big Round Can Hurt Your Startup
When you’re a struggling team eating away at your meager savings and trying to get your startup profitable, venture capital funding seems like the holy grail.
Raising money from investors gives you the resources to grow your team, buys you time to do things properly and gives you no small amount of credibility in the eyes of other entrepreneurs, prospective hires and even some clients — not to mention mom and dad thinking you’re now successful.
While all of this is true, there’s a pervasive belief in the industry that entrepreneurs should aim to raise as much money as possible, as often as possible. It might be true in some circumstances, but here are three reasons why raising as much money as possible is often not in the best interest of the entrepreneur or the company.
Raising Money Is Like Buying Dinner
When you sit down at a restaurant, you think about how hungry you are before ordering. If you’re only a little hungry, an appetizer should suffice. You wouldn’t order a nine-course pre fixe meal only because they’ll sell it to you: We all know those leftovers are just going in the trash.
Fundraising is like this — if you don’t need to order a massive meal to sate your appetite, don’t do it. Aside from the obvious temptation to waste (see next section), the reality is that you won’t be over-ordering with cash in your pocket or even debt — you’ll be buying too much food with equity, something you can only sell once!
Spending Money Is Like Getting Fat
It is much easier to put on weight than it is to take it off. The same applies to spending on your business — if you’ve got a big pile of money in the bank, the temptation (and even expectation) is to ramp up your burn rate and, in a sense, “let yourself go.” It’s awesome if these investments result in amazing growth (you getting taller), but for many entrepreneurs the extra spend goes to their waist more than their height.
Similar to a gold rush, in the tech sector, you’re better off selling shovels than looking for gold.
A friend was recently telling me about his own first-hand experience of raising money and getting fat. After building his company with a strong culture of bootstrapping and discipline, they were doing well and decided that they’d raise a $10 million round (even though the business was spinning off cash).
Within 12 months they’d blown almost half of their round on employee perks and executive recruiters for a failed expansion they then shut down. Even worse, they’d lost their tight, high-performing culture. Re-imposing discipline after letting themselves go was tough, especially knowing it was all due to a hunk of cash they used to “let themselves go.”
Raising Big Rounds Is Like Stunt Driving
When raising big, successive rounds at big valuations, the entrepreneur becomes a stunt driver — with their company as the car. To justify the valuation they just got, and with a big pile of money burning a hole in their pocket, the entrepreneur has to go for broke.
This, of course, entertains audiences (media, the public) and gets a great return for promoters (investors), but the one with everything to lose is the entrepreneur — if they crash, they end up in the hospital, and the car (their company) is written off. The promoter/investor reluctantly turns their attention to the other drivers/companies in their portfolio and the media waits for the next entertaining show.
What Drives The “More Is Always More” Myth?
What causes this mentality of raising all you can, whenever you can to be so pervasive? Here are a few reasons:
Investors are raising larger funds, and they need to invest that money in startups. They can either invest in more startups (which takes a lot more work) or they can put more money into the same number of companies — so obviously, investors have an interest in encouraging startups to take their money.
Similar to a gold rush, in the tech sector, you’re better off selling shovels than looking for gold. Lawyers, landlords, recruiters, brokers and other professionals benefit from selling services to growing tech firms — and the more money in tech, the more they stand to gain.
The media (and the public) don’t have great visibility into the metrics of private companies (revenue, customer growth, churn, etc.), so funds raised becomes the proxy for success, the way startups are measured. This ends up creating pressure for raising as much as you can — the bigger the number, the better the headline.
In the end, it’s most important as an entrepreneur that you focus on the right decisions for your company. Don’t raise funds to get a big splash in the tech press. Don’t push for the biggest valuation to please preferred stockholders. And don’t optimize for the fanciest publications or the most street cred. All of those things are fleeting sugar highs of entrepreneurship.
Plan for the long-term success of your company by knowing how much you actually need and stopping once you hit that number.
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